Wednesday, July 25, 2012

Bank Credit Analyst: All You Have to Do is Restore Risk-free Status to Periphery Debt

From The Economist's Free Exchange blog:How the euro was saved

...In June, Peter Berezin of the Bank Credit Analyst adopted the
viewpoint of someone looking back on the crisis from the year 2021, and
described what today must seem like a hopelessly idyllic outcome:

In
the end, the common currency survived. Indeed, over the past five
years, growth has accelerated sharply and debt levels and borrowing
spreads have continued to come down… While it was hard to imagine during
the dark days of 2012, European stocks have outperformed all other
major markets over the past decade.

How did Europe
get there? The reports of BCA, a Montreal-based research shop, stand out
for how incisively they diagnose the causes of the euro crisis and the
plausibility of the scenarios they sketch for its resolution. Mr
Berezin's June report accurately pinpoints the source of the crisis:
persistently higher inflation and slower productivity growth in the
periphery led to growing current account deficits with Germany.
Ordinarily, such deficits are solved by devaluation. In a monetary union
that's impossible; it requires either prolonged deflation in the
periphery, systematically higher inflation in Germany, or default -
either explicit, or via euro exit.

It is fear of this last
outcome that is driving the periphery's vicious circle of rising bond
yields, austerity, recession and deficits. Breaking that circle requires
restoring risk-free status to peripheral government debt. That could be
done via explicit debt mutualization through Eurobonds (i.e. Germany is
on the hook for Italy’s debts) or the European Central Bank, with its
unlimited buying power, becoming lender of last resort....MUCH MORE